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Why You Should Be Paying Attention to Inflation Right Now if You Have a Mortgage

Nov. 5, 2021
3 mins
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When the Bank of Canada made several rate cuts last year as a result of the pandemic, homeowners with a variable-rate mortgage were celebrating as lenders followed the central bank’s lead by cutting their prime rates.

However, the odds that the Bank of Canada will raise rates sooner than expected have increased because of a jump in inflation, which measures the rising prices of goods and services. You’ve probably have noticed this increase at the gas station, where prices are now much higher than they were before the pandemic began, and at the grocery store.

In fact, Canada’s annual inflation rate hit 4.4% in September – the highest level it’s been in 18 years. Supply chain issues and rising energy costs are two of the major reasons why the inflation rate is soaring. If you have a mortgage, particularly a variable-rate one, this should catch your attention. Here’s why.

How inflation is tied to mortgage rates

The Bank of Canada has a target for inflation of around 2%. Inflation is more than double that amount now, and the central bank expects inflation to reach close to 5% later this year. To keep the economy from overheating, the Bank of Canada can raise interest rates. While fixed mortgage rates are influenced by government bond yields, variable mortgage rates are influenced by the Bank of Canada’s policy moves when it comes to the overnight interest rate.

Lenders base their prime rate (currently 2.45%) on the Bank of Canada’s target for the overnight rate (currently 0.25%). Each time the central bank raises or lowers the overnight rate, lenders’ prime rates will usually go up or down by the same amount. For instance, when the Bank of Canada lowered the overnight rate three times (by 50 basis points each time) in March 2020, lenders reduced their prime rates by the exact same amount.

For those with a variable-rate mortgage, that means your interest rate will increase if the central bank raises the overnight rate. So if you locked in a low rate this summer, it may not be that long before you see it start to rise. While it’s not known exactly when the Bank of Canada will raise rates, it will depend on how long inflation continues to remain high and whether low rates are still required to prop up the economy.

What happens to my mortgage when interest rates rise?

As rates rise, so too will the amount of interest you have to pay with a variable rate. Your overall monthly payment will usually stay the same, but a greater portion of your payment will go toward paying interest and less will go toward paying down the principal. This means it will take a longer time to pay off your principal and you’ll end up paying more interest than when you first signed up for your mortgage.

Some experts have predicted that rates will begin to rise in 2022. BMO Economics, for example, expects the Bank of Canada to raise the overnight rate to 0.75% next year. On the other hand, TD Economics predicts the rate will reach 1% by the end of 2022. Based on those predictions, lenders’ prime rates could be between 2.95% and 3.2% next year.

It’s impossible to predict what will happen with inflation over the next year. But with inflation running high and the Bank of Canada expecting inflation to remain above its comfort level, the central bank may need to act. At a news conference last week, governor Tiff Macklem said: “it is our job to bring inflation back to target, and I can assure you we will do that.”

As interest rates begin rising, it’s important to compare mortgage rates online. Doing so will allow you to get the best rate and reduce your overall borrowing costs.

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Compare Mortgage Rates

Engaging a mortgage broker before renewing can help you make a better decision. Mortgage brokers are an excellent source of information for deals specific to your area, contract terms, and their services require no out-of-pocket fees if you are well qualified.

Here at RATESDOTCA, we compare rates from the best Canadian mortgage brokers, major banks and dozens of smaller competitors.

Craig Sebastiano

Craig Sebastiano is an award-winning writer and editor with more than a decade of experience in journalism, marketing, and communications. He’s written about a number of financial topics, including investing, real estate, robo-advisors, mortgages, credit cards, pensions, taxes, insurance, RRSPs, and TFSAs. Craig’s work has appeared in MoneySense, Morningstar, Benefits Canada, Advisor’s Edge, Job Postings, and Ryerson University Magazine. He has completed the Canadian Securities Course and is an avid do-it-yourself investor.

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